PHOENIX - The proliferation of IO mortgage product and adjustable rate mortgages over the past year was fodder for a lively debate about the future performance of such innovations in the mortgage market. Investors at Information Management Network ABS West 2005 conference held here last week, had varied opinions about the severity of the situation, but on the whole, no one seemed overjoyed.

Alex Wei, vice president at Delaware Investment Advisors, was one of the more concerned panelists, pointing out that IOs routinely comprise 10% to 20% of deals, and sometimes more. Compounding the problem is the fact that IO FICO scores have been declining. As the number of purchase loans decreases, issuers need to fill the gaps with refinance loans, such as IOs and ARMs, exposing those deals to a much greater risk if and when interest rates go up and monthly payments adjust upward.

"I don't know how subprime borrowers will come up with extra payments. Where will the extra money come from?" he asked. Wei noted that so far the performance of home equity pools has been good. Since many IOs and ARMs have two-to-five year adjustment periods, the real negative effects have yet to be seen.

Asked if the proliferation of IOs made in conjunction with piggyback loans is something to be concerned about, Phillip Wubbena, director at ACA Capital, said, "It absolutely is frightening."

Adding another level of concern is that investors are often not told whether loans in particular deals have piggybacks attached to them. "What percentage of the time are you being told there is a piggyback?" asked Brian Vonderhorst, director at Standard & Poor's. Investors simply have to rely on the information given, he added. Wubbena said investors should decide whether a deal is robust enough to handle the chance that some of the loans may have piggybacks, and bracket for that risk.

Copyright 2005 Thomson Media Inc. All Rights Reserved.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.